A trio of European automakers, including Volkswagen AG (OTC ADR: VLKAY), yesterday (Wednesday) released stronger than expected second-quarter results based on strong car sales in emerging markets.

In addition to Germany’s Volkswagen, France’s PSA Peugeot Citroen SA (OTC ADR: PEUGY) and Italy’s Fiat SPA (OTC ADR: FIATY) reported yesterday, and reaffirmed their outlook for the remainder of 2008, which gave all three shares a boost in European trading.

“Volkswagen’s successful model rollout, leaner processes and disciplined cost management are enabling us to grow profitability,” Chairman Martin Winterkorn said in a statement.

“The operating environment has become tougher and is demanding considerable efforts from the automotive industry. This does not make it easy for us. However, we are well-positioned and have the right strategy to master the tasks ahead of us,” Winterkorn added.

Much of the gain in earnings for all three European automakers was attributed to sales growth outside of the 15-nation Eurozone, where the number of new car registrations is actually on the decline. Emerging markets such as the BRIC nations of Brazil, Russia, India and China were strong markets for the European automakers.

“Peugeot and maybe Volkswagen will buck a downward profit trend in 2008,” Howard Wheeldon, senior strategist at London-based BGC Partners LP told Bloomberg News. “The European carmakers that suffer most” will be the manufacturers with less trade outside the mature western European and U.S. markets, he added.

European automakers also benefited from a currency conversion boost, as the euro remains strong against most other currencies.

Domestic Car Trouble 

While Europe’s carmakers are triumphing over maturing markets and high oil prices, U.S. automakers that have traditionally focused on larger, less-fuel-efficient models continue to struggle.

General Motors Corp. (GM) yesterday announced second quarter sales dropped 5% to 2.29 million vehicles, while Toyota Motor Corp. (ADR: TM) announced its sales gained 1.8% to 2.41 million vehicles.

Toyota’s new lead will likely bring to an end the 77 years GM has spent atop the global leader board as the largest automaker. In 2007, GM narrowly beat out Toyota by just 3,100 sales.

Outside of Europe and North America, GM saw a 16% sales increase fueled by strong demand in Latin America and Asia.

“There was not quite enough sales volume in these emerging markets to offset weakness in North America, more specifically in the U.S.,” GM’s chief sales analyst, Mike DiGiovanni, said in a conference call yesterday, Bloomberg reported. “The short-term outlook remains challenging.”

News and Related Story Links:

• Money Morning:
  GM Tries to Reverse Course, but Can it Catch Toyota?

• MarketWatch:
  European auto giants stand by 2008 forecasts

• Bloomberg News:
  VW, Peugeot, Fiat Beat Earnings Estimates, Defying Oil Gloom

• The International Herald Tribune:
  Results from European automakers confound gloomy expectations

• Bloomberg News:
  GM Falls Further Behind Toyota in Global Sales Race

From Staff Reports

In a bid to re-establish itself as the “pharmacy of the world” – and narrow the growing gap between itself and the United States and Asia – Europe is launching a $3.1 billion drug-discovery initiative.

The program – known as the “Innovative Medicines Initiative” – was unveiled in Belgium, and offers financial grants to both academic institutions and small companies to research ways of beating bottlenecks in the drug-development process. The work is “pre-competitive,” meaning it involves issues that are common to drug development, and doesn’t give any individual company a competitive advantage.

At one time, Europe was the worldwide center of drug development. But it’s fallen behind in recent years. A decade ago, seven of the world’s 10 newest drugs were being developed in Europe. But today that number has plummeted to only three.

“We hope to send a very clear signal to the world that Europe is getting serious again about being the centre of biomedical research,” Arthur Higgins, the chief executive officer of Bayer HealthCare and the president of the European Federation of Pharmaceutical Industries and Associations, told Reuters. “The greatest accolade will be if we are seen again as the pharmacy of the world.”

It will be a long-term process. Right now, it takes an average of 10 years and $1 billion to develop a new drug. The first research programs in the European initiative won’t start until next year and won’t generate “practical” results for a number of years.

The European Commission is to contribute $1.55 billion over the course of seven years, with major European pharmaceutical companies providing a similar amount – but “in kind,” meaning it will involve equipment and staff, instead of just cash.

The collaboration is the largest of its type in the world. Europe’s pharmaceutical industry has been campaigning for such an initiative for some time.
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The initial focus will be on diabetes, brain disorders and respiratory disease, with cancer and infectious diseases following later. The main goal is to discover better ways to predict the safety and efficiency of new pharmaceuticals. In that way, Reuters reports that it’s similar to the U.S. Food and Drug Administration’s so-called “Critical Path Initiative.”

News and Related Story Notes:

Reuters:
EU Launches a $3 Billion Project to Boost Drug Discovery

By Jason Simpkins
Associate Editor

Powered by the biggest German expansion in 12 years, the European economy shrugged off the U.S. slowdown to post first-quarter growth numbers ahead of analyst estimates.

Gross domestic product (GDP) in the 15-country Eurozone increased by 0.7% in the first three months of the year, Eurostat reported. Analysts had predicted a growth rate of 0.5%.

Germany and France – which together account for nearly half the Euro region’s GDP – made the difference. The German economy, the continent’s largest, expanded by 1.5% in the first quarter, compared with a growth rate of 0.3% in the final three months of 2007. France also turned in a respectable performance, advancing at a 0.6% clip.

Although the strong growth underscores the global economy’s resilience in the face of a sputtering U.S. economy, and appears to justify the European’s Central Bank’s focus on taming inflation, analysts warn the celebration may not last.

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A key cause for concern: Despite their strong performance, both France and Germany showed signs of declining consumer demand, which is why analysts are skeptical that such stellar growth can continue.

“A Chinese proverb says that it is better to light a candle than to curse the darkness,” Carsten Brzeski, an economist for Dutch finance group ING Groep NV (ADR: ING), told Reuters.” However, at the current juncture, one should not be blinded by the German GDP numbers.”

Indeed, earlier this month, data from Germany’s Federal Statistics Office showed retail sales in March were down 0.1% from February, and down 6.3% from a year earlier. Food, drink, and tobacco sales led the decline, as consumers cut back in the face of soaring inflation.  Consumer prices in April jumped 2.4%.

The story is the same for a multitude of other European nations. Eurozone inflation backtracked slightly in the month of April, sliding to 3.3% from a 16-year high of 3.6% in March, but remained well above the ECB’s 2.0% ceiling.

“There are significant pressures facing consumers in Europe,” Howard Archer, chief European economist at Global Insight Inc., told Forbes.com. “Higher inflation and soaring food prices are weighing down on consumer purchasing power in Europe. It is a depressing factor throughout the continent.”

“Consumer confidence is weak in Europe and low spending is bound to hurt the overall economy,” he added.

The European Central Bank (ECB) has remained hawkish on inflation, which it considers “the main problem that we have to face in the short term.” The ECB has held its benchmark interest rate steady at 4.0% for nearly a year now, despite an aggressive string of rate cuts by the U.S. central bank that has left the benchmark Federal Funds Rate at 2.0%.

Still, rising worldwide commodities prices and a weak U.S. dollar continue to drive up inflation throughout the Euro region.

The European Commission (EC), the executive branch of the European Union, said last month that Eurozone growth would continue to erode throughout 2008 and 2009.

The EC predicted the combined growth rate for the 15 countries that use the euro would slow to 1.7% this year and 1.5% next year. It was second time in six months that the commission has reduced its growth estimate for the region. In November the group was projecting growth of 2.2%.

According to the EC, “the recent sharp rises in food and energy prices have depressed households’ purchasing power and consumer spending in the last quarter of 2007 and are expected to continue to do so during most of 2008.”

If the Eurozone does lose its momentum in the months ahead, the ECB could find itself in a precarious position, as abiding inflation might keep the bank from cutting rates to spur growth.

“There is definitely no room for the ECB to cut rates,” Joerg Kraemer, chief economist at Commerzbank AG (OTC: CRZBY) in Frankfurt told Bloomberg News.

News and Related Story Links:

• Bloomberg:
  European Expansion Beats Forecasts, Led by Germany

• Reuters:
  German GDP stuns, Europe shines, but it may be over

• Forbes:
  European Retail Feels The Price Heat

• Money Morning:
  “Dire Inflation Outlook” for the EU and Sluggish Growth Add to ECB Woes

Barclays Bank PLC (BCS) announced yesterday (Monday) that it had purchased Russian bank Expobank for $745 million. The deal represents the latest European bank seeking to cash in on Russia’s fast-growing economy.

Russia’s annual lending growth is growing at a 45% clip, The Wall Street Journal reported, making it the fastest-growing banking market of the BRIC countries – Brazil, Russia, India and China.

U.K.-based Barclays, which already owns banking operations in Portugal, Spain and South Africa, has been looking to expand internationally, as the U.K. economy grew at less than 3% last year.

By contrast, Russia’s economy grew by 10%. And that prosperity is fueling the consumer lending business, as Russia’s emerging consumer class seeks auto loans, credit cards and mortgages, The Journal reported.

"Expobank is a well-run bank with a good track record of innovative distribution and represents a great opportunity for Barclays," Frits Seegers, Chief Executive, Global Retail and Commercial Banking, Barclays said in a statement.

Barclays’ expects to profit from the acquisition as early as 2011 and will finance the purchase with existing cash reserves.

The Expobank purchase represents the latest in a string of similar deals in which European banks made investments in Russia’s financial sector.

Just last month, Paris-based Societe Generale (OTC:SCGLY) increased its stake in OAO Rosbank. In June 2007, Italian bank Unicredit SpA acquired Moscow Bank. And Austria’s Raiffeisen International Bank purchased Impexbank in 2006.

News and Related Story Links:

• Barclays Bank PLC Press Release:
  Barclays to acquire Russian bank Expobank

• The Wall Street Journal:
  Barclays Looks to Expand In Russia With Expobank Buy

• Bloomberg News:
  Barclays Acquires Russia’s Expobank for $745 Million

Seeking to loosen global credit markets, the European Central Bank (ECB) pumped $501.5 billion into banks yesterday (Tuesday), adding liquidity and easing the cost of lending.

The rate for two-week loans dropped 50 basis points to 4.45%. That rate had spiked to 5.28% in the past two weeks, as banks froze cash anticipating a continued credit squeeze until the end of the year, the International Herald Tribune reported. Rates for one- and three-month loans also dropped.

"These are strong-arm tactics intended to show the market they’re seriously committed to breaking the deadlock," Marc Ostwald, a fixed-income strategist at Insinger de Beaufort Holdings SA in London, told Bloomberg News. "The ECB is helping to bankroll banks out of a problem that they themselves created."

The cash injection marks the second time in two weeks that central banks intervened to save lenders from the continued credit fallout. Last week, U.S. Federal Reserve Chairman Ben S. Bernanke cut the Fed’s key interest rate 25 basis points to 4.25% – the third rate cut in four months. The Fed followed up yesterday (Tuesday) with stricter rules to stop subprime mortgage lenders from doling out loans to unqualified borrowers.

More pertinent to Europe’s economy, the ECB’s liquidity boost comes on the heels of a massive $10 billion write-down last week from UBS AG (UBS), Europe’s fourth-largest bank.

Also last week, Forbes reported predictions that several other European banks will be facing write-downs: $4 billion for Deutsche Bank (DB), $3.2 billion for Societe Generale (SCGLY), $1.7 billion for Credit Argicole (CRARF), and a $1.4 billion write-down for Credit Suisse (CS).

And two weeks ago, Royal Bank of Scotland Group PLC (RBS), the U.K.’s second-biggest bank, announced it would write-down $3 billion.

If banks instill smarter lending habits and use this $500 billion wisely – and that’s a big if, considering what happened this year – it will help to stabilize their balance sheets and regain the trust of stockholders and the ECB.

News and Related Stories:

• International Herald Tribune:
  ECB pumps record $500 billion into money markets.

• Bloomberg:
  Money Market Rates Tumble; Central Banks Inject Funds.

• CNNMoney:
  Fed tightens up lending rules.

• Money Morning:
  Bad Day in Banking: UBS Offsets $10 Billion in Write-Downs With Sale of $11.5 Billion in Shares to Singapore.

Costumes with wide, padded shoulders, mindless soap operas about rich people and such [in retrospect] laughable musical acts as Culture Club and Boy George are 1980s routines that you likely abandoned a long time ago. But one routine from that decade – profiting from investments in Germany – is rediscovering its "glory days." And, unlike 80s-era pop music, the allure of investing in Germany is both rational and justifiable.

Germany has always had a strong economy, although investors there tended to lose out badly because of its regrettable tendency of invad ing neighboring countries. But after World War II, Germany was actually blessed with one of the better leaders of the 20th Century, a man who even 20 years ago had already been largely forgotten and whose name is today almost wholly unknown among younger Germans. The leader I’m referring to is Konrad Adenauer.

It’s both sad and unfair. Following, as he did, Germany’s most infamous leader, Adenauer has somehow been forgotten despite his many concrete achievements.

Indeed, Adenauer remained in power for 14 years [1949-63], and during that tenure slashed taxes, shredded the morass of often-pointless controls that [like many nations in Europe] had dragged down Germany’s post-war economy, and then presided over the "wirtschaftswunder" economic miracle that transformed the nation he led into the richest country in Europe – a position it had actually occupied before losing World War I.

B y the 1980s, everybody knew to invest in Germany.

Those "glory days" of the 1980s didn’t last as long as they could have or should have. Key leaders made some crucial mistakes, but the country’s real problems didn’t take hold until the 1990s. It started with the German reunification, which German leader Helmut Kohl foolishly carried out by equalizing the currencies of West and East Germany, making East German labor hopelessly uncompetitive. The result was 15 years of huge subsidies from West to East and a series of real estate disasters as Western construction companies overbuilt in the East.

Thus for several decades now, German growth has been pretty unimpressive. But there are signs that the country is returning to its former glories, with modest labor market reforms and tax cuts producing a more competitive nation. The costs of reunification have begun to decline – they were always likely to be a finite problem, as the Eastern education system was reformed and produced new, more productive workers – and the German growth rate has begun to increase. Notably, since the introduction of the euro in 1999, German labor competitiveness has increased by about 20% against rival European Union members, an outstanding showing. German companies have a healthy position in Eastern Europe, too, where economic growth has been rapid while wage growth remains far lower than in the West.

In a recent report, the IFO index of German business confidence rose to 104.2, a sign that the current 2.8% Gross Domestic Product (GDP) growth rate [equivalent on a per capita basis to a US rate of 3.8%, since Germany has zero population growth] is likely to continue. Only inflation, which has ticked up to 3%, is a problem, but the strong e uro should help that – while not doing much damage to Germany’s healthy balance of payments surplus.

So, what to buy? For a start, avoid the banks. There are too many banks in Germany, most of them propped up by their local governments. The banking system’s lack of good ideas for making money has recently been shown by two banks – IKB Deutsche Industriebank AG and Sachsen LB – that got in trouble by investing in U.S. subprime mortgages. Goodness knows what other U.S. problems are buried in German bank balance sheets, a product of enthusiastic U.S. salesmen and unimaginative German bank buyers. B est not to find out.

Instead, look to Germany’s great engineering companies. The largest, Siemens AG (SI), is still recovering from losses a couple of years ago and its stock price has been run up too high. However you might look at the electronics company Epcos AG (EPC). This was a spin-off from Siemens two decades ago, and now manufactures electronic components for the cell phone and tech industries worldwide, with factories in Europe, Asia and the Americas [so it is only moderately impacted by the strong e uro]. Its Price/Earnings ratio based on trailing earnings exceeds 14, but based on projected earnings is a very reasonable 10. You’re getting exposure to rapid growth – and at a very cheap price.

A second possibility is Fresenius Medical Care AG & Co. (FMS), the world’s largest manufacturer of kidney-dialysis machines, again a global company. This firm has a rather higher P/E ratio – about 23 times this year’s earnings – but its technological capability and strong market position create some attractive growth potential.

Finally, you can go to the telecommunications sector and try Deutsche Telekom AG (DT), which owns the U.S. wireless provider T- Mobile, which has enjoyed rapid growth in the American market. DT has had trouble recently because of declining landline revenue, but its mobile and Internet businesses are growing rapidly. I t currently sells at 20 times projected 2007 earnings, with earnings growth of around 12% forecast for 2008.

Investing in Germany might be coming back into fashion; it looks like a trend to follow.

News and Related Story Links:

• Money Morning:
  Nine Ways to Profit From the Diving Dollar

• Money Morning:
  Uncertainty Continues to Plague U.S. Financial Markets.

• Wikipedia:
  Helmut Kohl.

• Wikipedia:
  History of Germany.

• BruceSpringsteen.com:
  Glory Days.

Most people associate Bangladesh with catastrophic floods and chronic instability, but that country has actually come a long. According to the International Monetary Fund, growth is set to reach 7% this year, a 30-year high.

A military-backed government has pushed through a series of reforms, and 26 state-owned enterprises (SOEs) are slated for sale.

“It’s a quantum leap in the mindset of the government…that they’re embracing privatization,” says Yawer Sayeed, CEO of the first and only private fund manager in the country. Newfound political stability has encouraged foreign investment, and consumer consumption is also on the rise.

The Dhaka Stock Exchange Index has risen by about 80% this year amid these improved conditions. The market’s total value is a tiny $8 billion, says Pooja Thakur on Bloomberg.com, but it’s expected to double to more than $15 billion as privatizations provide further impetus and the market appears on foreign investors’ radar screens.

JPMorgan Chase & Co. (JPM), Merrill Lynch & Co. Inc. (MER), and Citigroup Inc. (C) – which last month became the first foreign lender to acquire a license to offer investment banking services – all reckon Bangladesh may be the “next Asian success story,” says Thakur.

Free-market U.S. conservatives like to talk about "old Europe." They tell stories about the sclerotic EU bureaucracy, the intransigent French unions, and the rigid German banking system.

Problem is, they ignore the really interesting Europe. The Europe that is growing rapidly. The Europe with soaring productivity, low inflation, small public sectors, an excellent education system, and high foreign investment in factories that quickly learn to undercut their neighbors in Western European.

This new Europe – centered around Poland, the Czech Republic, Slovakia and Hungary – is difficult for the average U.S. investor to buy. But there are still some inbound pathways with solid profit potential. Let me explain…

The Productive Key to Growth

As my readers in the Money Map Report know, productivity growth is the key to long-term gains. The United States manages productivity growth of just over 2% a year, Western Europe a little less, and Latin America an abysmally low 1% per annum.

At the opposite end of the spectrum, wealthy Asian countries like South Korea and Taiwan enjoy productivity growth of more than 4% a year. This makes their companies more competitive year by year against their Western counterparts.

Poland, Hungary, the Czech Republic and Slovakia are all quite wealthy – much wealthier than their neighbors further east. Yet each of their productivity growth rates over the last five years are almost up to Asian standards: Poland (3.1%); the Czech Republic (3.3%); Hungary (3.4%); and Slovakia (4.9%).

Real economic growth was also good in 2006, clocking in at 6.1% in Poland, 6.4% in the Czech Republic, and 8.3% in Slovakia.  Only Hungary (3.9%) was a little slower. Inflation, budgets, and balance of payments are all in balance or, at worst, are in a modest deficit.

The lower growth in Hungary illustrates the one remaining political problem in the region. Electorates in former Communist countries like to throw their governments out every few years. (I guess it’s partly the thrill of being able to do so after so many years under Communism.)

However, throwing one government out means putting another one in, and in all these countries, until now, the Socialists have been the replacement party. The Socialists are generally opposed to the free market, corrupt and full of survivors from the Communist regime.

That slows down economic progress, as it has in Hungary, where the Socialists have been back in power since 2002.

In Slovakia, the bad guys were in power until 1998, but were then succeeded by a wonderful reformist government under Mikulas Dzurinda that introduced a 19% flat tax and brought rapid economic growth. Alas, after the World Bank praised the Dzurinda government as the "best reformist government in the world," the Slovakian prime minister lost the 2006 election. So the country’s stellar growth in 2006 is likely to be the last such performance for some time to come.

Poland, at last, found a way around this progress blockade. In Sunday’s election, the ruling "social-conservative" Law-and-Justice government was thrown out – but wasn’t replaced by the Socialists, who got only 13% of the vote.

Instead, they were replaced by the "economic-conservative" Civic Platform. Since Law and Justice were themselves pretty competent economically, the Polish electorate can now enjoy the pleasure of throwing out its governments, while replacing them only with other governments equally committed to the free market and economic growth.

This is wonderful news for investors in Poland. And since these four countries tend to copy each other, it is likely to be wonderful news in the long run for investors in the other three countries, as well.

How to Play Emerging Europe

Since few stocks or American Depository Receipts (ADRs) are traded on the U.S. exchanges, the best bet for emerging Europe is the Spider Standard & Poor’s Emerging Europe (GUR) exchange-traded fund (ETF). It invests in the share indexes of the Czech Republic, Hungary, Poland, Russia and Turkey.

However this ETF was only founded in March, and currently has a market capitalization of only $39 million. That’s up from $29 million a month ago. Of the five countries I just listed, Turkey’s also a good bet (though it may hiccup from the Iraqi-Kurdistan problem). I would only be nervous of Russia.

There is also a closed-end fund, the $180 million Morgan Stanley Eastern Europe Fund (RNE), which trades at around net asset value. However, it has a high expense ratio of 1.6%, and invests mainly in Russia.

Mutual funds are usually for the risk averse. But in the case of the San Antonio, Tex.-based U.S. Global Investors Inc. (GROW), mutual funds are worth a look by conservative and aggressive investors alike. The reason: U.S. Global’s funds are almost always top performers. Their U.S. Global Accolade Eastern Europe Fund (EUROX) is no exception. You can invest in it with confidence.

News and Related Story Links:

• Money Morning Investment Analysis:
  Three Ways to Profit from a Messy Market.

• Boston.com:
  Opposition Wins Poland Election.

• Money Morning Investment Analysis:
  When Corruption is Low, Your Profits are High.

• Wikipedia:
  Socialism.

• Money Morning Investment Analysis:
  U.S. Global Investors to Focus on Global Infrastructure Investment Opportunities.

• Wikipedia:
  The Economy of the Czech Republic.

• Wikipedia:
  The Economy of Slovakia.

• Wikipedia:
  Mikulas Dzurinda.

Heineken NV (HINKY.PK) has entered into talks with Carlsberg A/S (CABHF.PK) regarding a joint takeover bid for Scottish & Newcastle PLC. The two companies have not made any formal approach, but have said any takeover offer would be in cash. The unexpected announcement came in a joint statement released Wednesday, according to the AFP news service.

"Carlsberg and Heineken confirm that they are in discussions regarding the formation of a consortium to make an offer for the entire issued share capital of Scottish & Newcastle," the statement said.

Scottish and Newcastle, whose brands include Fosters lager and Strongbow cider, said it was confident in its future as an independent group. S&N officials are reportedly "furious" over the reported takeover bid, which would result in the company being split up between the two suitors, and said in response that "the proposed break-up bid from Heineken and Carlsberg, the company’s joint venture partner in BBH (Baltic Beverages Holding), is unsolicited and unwelcome."

Scottish and Newcastle has been the subject of takeover speculation all year long.

Carlsberg, the largest Nordic brewer, and Scottish and Newcastle are currently partners in the BBH joint venture.  Baltic Beverages owns Russia’s largest brewer with a 38% market share, and other interests based in France and Greece. Its revenue grew 36% in the first half to $856 million, while operating profit soared 48%.

If the takeover is successful Carlsberg will take complete control of BBH, and the French and Greek operations, while Heineken would get the U.K. and European brands. The statement didn’t specify who would get S&N’s Asian assets.

Analyst Richard Withagen at SNS Securities told the AFP news service that the Heineken-Carlsberg takeover was a smart move.
"I think from a strategic point of view it’s obviously a good deal for Heineken and Carlsberg," Withagen said, "Heineken would gain market leadership in the UK and become the number two in Belgium and Portugal, and a leading market player in Finland."

In addition to advancing in Belgium and Portugal, a successful deal would give Heineken the top spot in the U.K. where it currently commands less than 1% of the  market.

The takeover would also help the two companies to keep pace with SABMiller and Molson Coors (TAP) who recently joined forces. That brewery union could save as much as $500 million a year in manufacturing and shipping costs and provide the combined entity with 30% of the U.S. beer market.

News and Related Story Links:

• Money Morning Investment Analysis:
  Thirsty for Profits? Ten Ways to Play the Worldwide Beer Market.

• AFP:
  Scottish and Newcastle snubs possible bid from Carlsberg, Heineken.

• Bloomberg:
  Carlsberg, Heineken in Talks for Scottish & Newcastle.

• The Financial Times:
  Carlsberg, Heineken Poised For S&N Bid.

• The Physics Factbook:
  Volume of World Beer Consumption.

Citigroup Inc. (C) is preparing to lend Northern Rock PLC – the United Kingdom bank bailed out by the Bank of England – $20.4 billion so it can buy time for a buyout, according to news reports from both Bloomberg News and the Financial Times.

Northern Rock desperately needs to refinance 14 billion British pounds Sterling in the second half of this year, and 30 billion pounds over the next year. The Citigroup loan would equate to approximately 10 billion pounds.

Reportedly, private equity firms such as Apollo Management LP, The Blackstone Group LP (BX), Flowers & Co., and Cerberus Capital Management LP, have been actively engaging Northern Rock in takeover talks.

Northern Rock hired Citigroup last week to join Merrill Lynch & Co. Inc. (MER) as an advisor in those discussions.  Citigroup’s size has allowed it to step in with a big loan package, where Merrill Lynch, a smaller firm, could not, according to published reports. It’s possible that Citigroup could end up as the head of a coalition of banking agents helping Northern Rock to refinance its debt, the media reports stated.

A government guarantee has also bolstered Northern Rock’s position. The Bank of England, the U.K. Treasury, and Financial Services Authority will cover money deposited after Sept. 19.  Northern Rock has said the deposit guarantee and central bank funding will enable to company to engage in takeover talks until February.

“It gives them more breathing space in a difficult time,” James Hutson analyst at Keefe Bruyette, & Woods Ltd. of London told Bloomberg.  The proposed plan covers all retail deposits including future interest payments and the transfer of funds. 

Northern Rock’s stock closed up nearly 20% Tuesday on the London exchange. It’s up more than 50% over the past five days.

News and Related Story Links:

• Financial Times:
  Citi prepares to be a knight in shining armour

• Bloomberg:
  Northern Rock Shares Rise After Citigroup Loan Report